Current Issue

Apr.1, 2009

Vol. 109, No. 11

Worrisome investing

In response to: In the News

PAW unfortunately reused the University’s term “sold” when describing the issuance of $1 billion in long-term taxable bonds (Notebook, Feb. 11). While not technically inaccurate, “sold” also could mean that bonds held in the portfolio were redeployed into equities that have become less expensive than they were in recent years. Alas, that is not the case.

Our beloved University has engaged in a long-term course of financial conduct that is likely now to be shown to be short on logic and long on detrimental ramifications. Having been told in the Bowen era that “excellence can’t be bought, but must be paid for,” supporters for years have generously granted Princeton substantially more financial resources. The ensuing excellence has combined with increased internationalism and the effects of greater financial support to a wider economic base so as to lead to an ongoing increase in the number of suitable applicants. Moving into nontraditional investments resulted in eye-popping (and, unfortunately, clearly unsustainable) returns, creating a sense of additional wealth that has facilitated the creation of more physical plant and educational infrastructure to accommodate more students. All of this results in a cost structure substantially higher than before that could be reversed only with substantial pain.

In pursuing these moves, Princeton has embraced the use of financial leverage and entered into commitments that could well result in a Pandora’s box. The 2007 treasurer’s report (the most recent available on the University’s Web site) cites $5.4 billion of unfunded commitments to certain limited-partnership agreements. It would appear that such partnerships fall into the 51 percent of the (2007) portfolio that was accounted for by “independent return” (a name that George Carlin really could have had fun with, and assumed to be hedge funds) and “private equity.” So with just over half of the University’s wealth in investments that have either promoted the deleterious volatility in various markets or been crucial to the pattern of leveraging up companies that have eliminated hundreds of thousands of jobs in order to score a return on investment that has absolutely no relation to the underlying economic value, an additional claim of billions of dollars on future investments has been created.

Perhaps the most bizarre aspect of this exercise is trying to appropriately weight the significance of Deloitte & Touche’s observation in the auditor’s report that “… the financial statements include investments valued at $6.497 billion (38 percent of net assets [note: 41 percent of net investments]) … as of June 30, 2007…whose fair values have been estimated by management in the absence of readily determinable fair values. Management’s estimates are based on information provided by the general partners or a valuation committee.” One wishes that the same sort of valuation technique could have been included on grades sent home during undergraduate days.

In the 2007 report on investments, a telling comment is offered: “With long-term expectations of University inflation approximating 5 percent or more, the endowment must seek investment returns approaching or exceeding 10 percent per year to maintain future purchasing power without a deterioration of corpus.” This is stated as fact. But University inflation is different than household inflation. Much of the expense stream is due to compensation costs, which are a lot easier to influence than my cost per kilowatt/hour from PSE&G. And holding out the returns target raises questions on two counts. After a period of excess returns (much of which had been generated by self-reporting investment pools), doesn’t a reversion to long-term averages make 10 percent a wistful number? And, more importantly, shouldn’t we be worrying less about a deterioration of corpus and more about a deterioration of anima?

Leadership takes several forms. A leading university has the role, if not the mandate, of discerning and implementing eternal truths for an unbounded greater good. The point of creating and maintaining a collective intellectual enterprise is to find the lessons from the past and tackling the unknowns of the present so as to best serve the future. For much of her existence, Princeton has done just that. But when a department incorporates “financial engineering” in its title, it is a dead giveaway of how off-track things have become — like “business casual,” there are some words that are best left unconnected. It’s not like our world is suffering right now because of a period of insufficient financial complexity. And we should never lose sight of the notion that complexity is a tool often used by the mendacious for exploitation and (as the sports announcers so succinctly put it) “trickeration.”

Princeton should be and needs to be in the vanguard of a resurgence of simplicity. There are elemental concepts that are the bedrock of sustainability. Because they are simple or elemental does not mean that they are easy – either to identify or to promulgate – and it also does not mean that they lack immense value.

It’s time to restore order, and Princeton’s financial position is a good place to start. Let our University become a beacon to others by acknowledging that the magnitude of financial resources in our care creates a serious trust to our country and our world. Let her go forth in the nation’s service (and in the service of all nations) by showing restraint by choice. And let us make sure that the University that we all love and cherish does not end up constrained by poorly conceived and poorly constructed financial policies and positions that do no service to any of these constituencies.

Tad LaFountain ’72
Princeton, N.J.
Editor’s note: LaFountain is a former investment-bank director of research with an M.B.A. from the Wharton School. A condensed version of this letter was published in the April 1, 2009, issue of PAW.

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3 Responses to Worrisome investing

Tad LaFountain '72 Says:

2009-04-03 10:15:39

Since this was written, the 2008 financials have been posted on the University website (although the full Treasurer's report doesn't yet seem to be available). The $5.4 billion of unfunded commitments grew by $700 million over the 2007/8 fiscal year to reach $6.1 billion.

Paul Hutter '76 Says:

2009-04-06 09:50:52

I agree with Tad La Fountain's viewpoint. The endowment's high-risk portfolio structure has 1) created massive losses when mark-to-market (reality) is applied; 2) destroyed liquidity and cash flow for many years to come; 3) severely undermined the University's ability to meet future commitments and obligations. This discussion about the correct investment policy is more than an academic exercise as the very viability of the institution is at stake. June 30th is PRINCO's opportunity to provide a full and transparent accounting, including mark-to-market valuation, so that alumni and other stakeholders will have a clear view of the endowment status.

Mike Devine '62 Says:

2009-05-20 09:26:06

Tad's letter and Paul's comment are getting close, but they both miss the point -- see "passed ball" in tuitionfreeprinceton.blogspot.com
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